Loan modification often doesn’t do enough to help underwater homeowners. Borrowers who can successfully modify their loans end up with a lower interest rate, but a much longer repayment period. Ultimately, they end up with more debt than they started with.

Perhaps the most fair – and most effective – way to handle the housing crisis is through a process called “mortgage cramdown.” The process allows a bankruptcy judge to reduce the principal on the loan to a level in line with the property’s actual fair market value.

Mortgage Lenders Have Blocked Cramdown Legislation

Mortgage cramdown legislation was originally included in the 2009 bankruptcy reform bill. It passed the House of Representatives but was quashed by the Senate in the wake of heavy opposition from the banking industry.

The banks’ opposition is disappointing but unsurprising. Mortgage cramdowns would require the major banks to properly recognize billions in losses, which may reveal that many of them are teetering on the brink of insolvency.

Of course, this is not the reason banks give publicly for their opposition to the legislation. They say cramdowns would create a “moral hazard” by allowing Americans to shirk responsibility for their debt – completely ignoring the fact that most homeowners are underwater because of forces beyond their control, like an over-inflated housing market and pervasive patterns of fraud.

Banks also say that cramdowns will cause interest rates to skyrocket, but this has not been borne out by history. In the 1980s Congress allowed cramdowns on farm loans, and the cost and availability of those loans has not changed dramatically since the reform. In fact, the interest rates are on par with the conventional home loan.

One thing is certain – millions of Americans have been unduly harmed in the financial crisis. The government must find a way to stem the tide of foreclosures before millions more lose their homes. The housing crisis doesn’t just damage individual borrowers, it damages our whole country.